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Stocks Plunge and Implied Volatility Soars

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Stocks Plunge and Implied Volatility Soars

Stocks started the Tuesday trading session on a positive note after experiencing the worst start to February since 1982. Stocks were hammered after the Institute of Supply management released a much worse than expected manufacturing report which many believe was a function of the very cold weather that has dominate the landscape in the United States. Despite stronger than expected earnings, stocks have declined slightly more than 5% since hitting their highs in January.

Implied volatility has also soared, as investors scramble to hedge their portfolios. The rate on the “at the money” strike puts and calls has moved up to 21.44% from 12% just 10-days ago. The 80% climb is one of the quickest increases in implied volatility seen in the past 5-years.

Implied volatility is the markets estimate of how much a security will move over a certain period of time calculated in percentage terms on an annualized basis. The VIX represents implied volatility for the S&P 500 index, and the level is how much option traders think the S&P 500 will move on an annualized basis.

The VIX is pushing up against resistance as the 50-day moving average is poised to cross above the 200-day moving average. This would represent a long term trend in a product that is generally mean reverting.

chart-stocks-plunge-implied-volatility-soars.png

Momentum is strong with the MACD (moving average convergence divergence) index printing at its highest levels in the past 6-months. One caveat to the strong move is the print of the relative strength index (RSI) which is now 74, and above the overbought trigger level of 70. This print in the RSI for the VIX could represent an overbought condition which could lead to a correction in implied volatility.

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